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5.4.2 objectives of supply-side policy: increasing productivity and productive capacity

5.4.2 objectives of supply-side policy: increasing productivity and productive capacity

Objectives of supply-side policy

Definition

Productivity: output per unit of input, such as output per worker or per hour worked.

Production: the total quantity the economy actually produces in a period.

Productive capacity: the maximum output the economy can produce when resources are fully and efficiently used.

Raising productivity

Productivity:

outputinput \dfrac{\text{output}}{\text{input}} inputoutput​
  1. The first objective is to raise productivity.
    1. Higher labour productivity means each worker produces more output in a given time.
    2. This lowers firms' cost per unit of output, so unit costs fall.

Increasing productive capacity

  1. The second objective is to raise productive capacity.
  2. Greater capacity is shown by a rightward shift of the long-run aggregate supply (LRAS) curve.
    1. It can also be shown by an outward shift of the production possibility curve (PPC).
  3. Both objectives improve the quantity and quality of the factors of production, not aggregate demand.
Key Idea
  • Supply-side policy targets a rightward shift in long-run aggregate supply.
    • This raises the economy's potential output rather than its spending.

Why the objectives matter

  1. Higher capacity supports faster potential economic growth over time.
  2. A larger capacity eases inflationary pressure, since demand can rise without hitting supply limits.
  3. Higher productivity lowers unit labour costs, improving international competitiveness.
    1. Stronger competitiveness can support exports and the current account.
  4. The gains depend on firms and workers responding, and appear only over years.
Example
  • Suppose a £2 billion training scheme lifts output per worker from 100 to 120 units per year.
Productivity gain=120−100100×100=20% \text{Productivity gain} = \dfrac{120 - 100}{100} \times 100 = 20\% Productivity gain=100120−100​×100=20%
  • Each worker now produces 20% more, so unit labour costs fall and capacity rises.
    • On an AD/AS diagram (average price level against real output), LRAS shifts right from LRAS1 to LRAS2.
  • Equilibrium real output rises while the average price level eases, meeting both objectives.

Do these objectives reliably deliver their promised gains?

  1. Pursuing higher productivity and capacity is attractive because, unlike a demand boost, it can raise growth, ease inflation and improve competitiveness at the same time, so a single set of objectives addresses several macroeconomic goals at once.
  2. However, the objectives are hard to hit: the gains appear only over years, they depend on firms and workers actually responding to the policy, and extra capacity delivers nothing if aggregate demand is too weak to use it.
  3. On balance, these objectives are worth prioritising when the economy's binding constraint is genuinely low productivity or a shortage of capacity and policymakers can wait for results; where the immediate problem is deficient demand, raising potential output alone will not close the gap, so it depends on the cause of the problem and the time horizon.
Exam technique
  • State the objectives precisely as raising productivity and productive capacity.
    • Link them to a rightward shift of LRAS or an outward shift of the PPC.
  • Distinguish productivity, output per input, from total production.
Common Mistake
  • Do not describe the objective as raising aggregate demand.
    • Supply-side policy expands productive potential, not spending.
  • Do not treat productivity and production as the same thing.
Self review
  • Define productivity.
  • What is the difference between productivity and productive capacity?
  • How is a rise in productive capacity shown on an LRAS diagram?
  • Why can raising capacity reduce inflationary pressure?
  • How does higher productivity improve international competitiveness?
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Supply-side policy aims to raise productivity and productive capacity. It improves the quantity, quality, or efficiency of factors of production, rather than directly increasing aggregate demand.

Productivity is output per unit of input, such as output per worker or output per hour. Production is the total output actually produced, while productive capacity is the maximum output possible when resources are fully and efficiently used.

These distinctions matter because production can increase without productivity rising. For example, a firm may produce more simply by employing more workers.

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Productivity is [     ].

5.4.2 objectives of supply-side policy: increasing productivity and productive capacity Revision Guide

  1. Intl A Level
  2. /Economics
  3. /5.4.2 objectives of supply-side policy: increasing productivity and productive capacity

Revision notes for CIE Intl A Level Economics 5.4.2 objectives of supply-side policy: increasing productivity and productive capacity: explanations and worked examples.